Rehabilitating a Lopsided Portfolio

"We thought we were set," says Don Radosevich, 70, who, with his wife Sherry, 66, began phasing into retirement in 2006. A generous stock market over the years had helped build their portfolio, heavily weighted in stocks and stock mutual funds, to about $1.5 million. That money, plus Social Security, part-time earnings from Don's legal practice and Sherry's job as a nuclear medicine technologist would easily allow them to finance lives split between their four-bedroom home in Wisconsin and a condo in Florida.

Don, like everyone else, was enthralled by the stock market’s seemingly unstoppable surge in value in the past 20 years. He recalls, with something like nostalgia, that “from 1990 to 2000, everything tripled” in their portfolio. (He also remembers reading that stock market returns “would average about 15 percent a year.”) The result: The Radoseviches sank the bulk of their nest egg into stocks.

Then came the market collapse of 2008. Almost overnight, the Radoseviches saw their savings slashed by $800,000. (Generally, 401(k)s and IRAs dropped in value by 40 percent when the market collapsed.) They panicked and sold all their stock mutual funds by January. For their troubles, they were hit with a tax bill of nearly $15,000. They kept only the stock they held in three Wisconsin companies: two banks, and the Manitowoc Company (MTW), which manufactures cranes and commercial food equipment.

Seeing the market rise precipitously in the past couple of months, Don decided to try to ride the stock escalator again. He moved $113,000 in his IRA from a government bond fund into SPY, an exchange-traded fund that tracks the Standard & Poor’s 500 index. (An ETF is a basket of stocks that approximate a financial index. Unlike a mutual fund, however, which is priced only once a day, an ETF can be traded throughout the day like a stock.) That investment is now worth about $120,000.

Even before their investments took a hit, however, the Radoseviches had begun looking for what they hoped would be safer options. On the advice of a broker, Sherry purchased a $195,000 tax-deferred variable annuity for her IRA in August 2008; the investment appealed to the couple partly because the insurer promised a bonus of 10 percent if they kept the money locked up for three years. Don and Sherry have also been pondering a broker’s recommendation that they use another $190,000 in Sherry’s IRA to purchase an equity-indexed annuity.

“My wife wanted me to put the money in a holding tank a long time ago,” Don says, ruefully. “She relied on my investing, which did very well for a long time. We had a lot of these good stories — the Manitowoc Company stock is one we rode up big-time; it went from about $4 a share to $51. Then it fell down to around $5.” (The stock subsequently doubled to $10, but is far below its boom-time levels.)

MoneyWatch.com editor-at-large Jill Schlesinger, a certified financial planner, praises the Radoseviches for having “done the heavy lifting. They have accumulated a nice nest egg and, despite their portfolio losses, they should enjoy a financially secure retirement. But there are details to be ironed out to get there.”

The Radoseviches’ portfolio, she notes, would probably have sustained less damage if they had not concentrated so much in one type of investment. Says Schlesinger: “People in retirement with worries about making their money last should never have more than 50 percent of their total holdings in stock — ever.” Now that Don has reinvested $113,000 in his S&P 500 ETF, about $400,000 or 53 percent of their $750,000 sits in stocks. Nearly $300,000 is concentrated in just three individual issues, two of them in the same sector: banking. The couple must reallocate the remaining cash in a way that will give them the possibility of earning more without endangering what they’ve got. That means selecting a broader range of investments. With a diversified approach, Schlesinger says, “the Radoseviches — and anyone who is on the cusp of retirement — will be better prepared to absorb market volatility.”

Diversify the Retirement Funds

Schlesinger recommends Don and Sherry each create a balanced IRA portfolio with index mutual funds that expose them to stocks (both U.S. and international) and bonds (high-quality corporate plus some exposure to high-yield or junk issues). She also suggests that they use a very small percentage of each portfolio to invest in energy and gold stock funds. (See pie chart below.)

Schlesinger also advises Don to balance the S&P 500 ETF in his IRA by “adding a more conservative bond fund to the mix. If he wants to keep using ETFs, he can buy IShares iBoxx $ Investment Grade Corporate Bond (LQD),” she adds. Alternatively, he could purchase the Vanguard Total Bond Index Fund (VBMFX).

Sherry should sell the $35,000 in Manitowoc stock in her IRA. That, when added to the $187,000 in cash would give her $222,000 which she could redeploy along the lines Schlesinger recommends below.

Sell Individual Stocks to Pay Taxes

The Radoseviches still owe about $15,000 on their 2008 taxes. To raise the money, first they should use the proceeds from the sale of Manitowoc stock in Don’s non-retirement account, Schlesinger says. (Rationale: It’s cheaper to pay the maximum 15 percent capital gains tax, which is what the sale in the brokerage account will trigger, than the 25 percent income tax that people in their tax bracket would pay on withdrawals from retirement accounts.) After that, he should sell more Manitowoc shares from his IRA.

Don’t Even Think About Another Annuity

Investing $195,000 of Sherry’s IRA money in a variable annuity was not the best move the Radoseviches could have made. “Variable annuities are rife with high expenses,” adds Schlesinger. “In 90 percent of the cases I have seen, it has not been the most efficient solution to an investment problem.” And putting a tax-deferred annuity within a retirement account, which is already tax-deferred, makes about as much sense as putting ketchup on tomatoes. There’s no good reason to do it. The Radoseviches should firmly reject their broker’s suggestion to invest in an equity-indexed annuity. The Financial Industry Regulatory Authority has issued a consumer alert, warning that EIAs are larded with fees and have near impossible-to decipher methods for determining returns.

Set Aside Money for Emergencies

A reserve is essential for every family. “I usually recommend three to six months of living expenses, Schlesinger says. When folks are retired, the amount should be increased to six to twelve months.” She suggests that the Radoseviches liquidate Sherry’s $100,000 of bank stock to make a down payment on such a fund.

Don’s Response

“Diversifying our portfolios makes sense to me. I was leaning toward selling the 1,100 shares of Manitowoc stock, and Jill tipped me over. Still, it was hard to part with. We’d bought two houses with the profits from that stock.” And although he adds that Sherry always liked the dividend from her bank stock, now about 3 percent, on Schlesinger’s advice they have sold $30,000 worth to pay down their home-equity line of credit.